November 19, 2008

The G-20 and Executive Compensation

The fact that executive compensation has emerged as a key concern coming out of the financial crisis was confirmed this past weekend at the meeting of the G-20 nations in Washington DC. As noted in this White House Fact Sheet, the G-20 leaders came together to “discuss efforts to strengthen economic growth, deal with the financial crisis, and to lay the foundation for reform to help to ensure that a similar crisis does not happen again.” The leaders pledged to take a more coordinated effort in dealing with reforms for the financial system, while also seeking to promote global economic growth.

Coming out of the talks was a “Declaration of the Summit on Financial Markets and the World Economy,” which lays out the collective findings of the group on the causes of the financial crisis and the actions that are pledged to be taken. Among the immediate actions that the countries pledged to address by March 31, 2009 was that “[f]inancial institutions should have clear internal incentives to promote stability, and action needs to be taken, through voluntary effort or regulatory action, to avoid compensation schemes which reward excessive short-term returns or risk taking.”

This concept of addressing compensation arrangements that encourage excessive risk taking closely parallels the recently enacted provisions of the Emergency Economic Stabilization Act of 2008 (EESA) and the implementing regulations, which specify that any institution participating in the EESA programs must structure its executive compensation program to exclude incentives for its senior executive officers to take unnecessary and excessive risks that threaten the value of the institution.

Since the EESA and the Treasury’s regulations only apply to financial institutions taking bailout money, this new G-20 pledge may compel the US government to take further action to impose similar requirements on all financial institutions over the coming months. The pledge does seem to leave some room for approaches short of new regulation, since it refers to “voluntary” efforts in addition to regulatory action. One issue that will inevitably come up if Congress takes action on this matter is whether the policy bias against compensatory arrangements that encourage excessive risk taking will be broadened outside of the realm of financial institutions, particularly in light of the dire straights faced by other industries seeking government assistance.

This morning, the SEC will consider adopting final rules in another area that was a focus in the G-20 talks – strong oversight over credit rating agencies. The SEC will consider rules, proposed earlier this year, that would impose additional substantive requirements on NRSROs that seek to address significant concerns about the integrity of credit rating procedures and methodologies.

Moving Toward a CDS Clearinghouse

Another one of the near term goals of the G-20 was to speed efforts to reduce systemic risk arising from credit default swaps (CDS). US financial regulators have been moving very quickly on that front, recently announcing a Memorandum of Understanding among the SEC, the Federal Reserve Board and the CFTC dealing with central counterparties for over-the-counter credit default swaps.

The President’s Working Group on Financial Markets has been actively nudging market participants to establish central clearinghouses for CDS (which conceivably could ultimately be used for other types of OTC derivatives). The PWG believes that “[a] well-regulated and prudently managed CDS central counterparty can provide immediate benefits to the market by reducing the systemic risk associated with counterparty credit exposures. It also can help facilitate greater market transparency and be a catalyst for a more competitive trading environment that includes exchange trading of CDS.” The MOU paves the way for the regulators to quickly approve these new central counterparties and get them up and running soon.

TARP: Private Institutions Documents Released

Earlier this week, the Treasury released the term sheet and Q&A for private financial institutions participating in the Capital Purchase Program. The deadline for applications is December 8, 2008.

– Dave Lynn